options, future contracts and other financial instruments and are capable of big gains (or losses) in short time periods.
While these funds seem to be attractive and have produced handsome returns YTD, investors should note that they involve a great deal of risk when compared to traditional ETFs. Most leveraged products are only designed to match the performance of an index over a single trading session, leading to possible deviations in the long-term holdings of these securities from an underlying index.
Thus, these products are not suitable for long-term buy as these are rebalanced on a daily basis and can produce terrible performances as a result. This can happen particularly during periods in which deep trends are absent, and markets are oscillating between gains and losses. Instead, investors could hedge their exposure or make a short-term play with these products on the bullish market.
Leveraged ETFs in Focus
Leverage ETFs are often more costly and can be less tax-efficient. As a result, investors seeking leveraged exposure in the space should monitor the funds closely and manage their portfolio on a daily basis in order to make the best decisions.
With that being said, some have done quite well over the longer term and have produced robust gains so far in 2013. Below, we highlight some of the best performing leveraged products this year, which have easily crushed the market—with much greater volatility—to start the year:
Direxion Daily Semiconductor Bull 3x Shares (NYSEARCA:SOXL)
This fund delivered a return of over 34% and managed assets of $76.5 million so far in the year. It seeks to deliver thrice (3x or 300%) the daily performance of the PHLX Semiconductor Sector Index, before fees and expenses. The index measures the performance of the semiconductor segment of the U.S. equity market.
The fund has a nice mixture of all cap securities with 46% of the assets assigned to large caps, 41% to mid caps and the rest to small caps. An extra cost shouldn’t be an issue in terms of bid ask spreads, as the product trades in average volumes of over 350,000 shares a day.
Direxion Daily Energy Bull 3X Shares (NYSEARCA:ERX)
With AUM of $190.8 million, this fund gained over 29% YTD and is skewed towards large cap securities. It seeks to deliver three times the daily exposure of the Energy Select Sector Index. The index measures the performance of companies from the oil and gas, consumable fuels, oil, and gas equipments and services etc (read: Energy ETFs: Strong Start to 2013).
Volume is extremely high in this fund, coming in at just under one million shares a day. This suggests that liquidity is quite high and that bid ask spreads shouldn’t be too big of a concern.
Direxion Daily Healthcare Bull 3X Shares (NYSEARCA:CURE)
This fund, targeting the healthcare sector, generated returns of about 28% YTD. It seeks to deliver thrice (3x or 300%) the daily performance of the Healthcare Select Sector Index, before fees and expenses. The product focuses on large caps with pharmaceuticals as the top sector within the healthcare.
The ETF failed to garner investor interest with just $13.4 million in its asset base and paltry trading volume of only 5,000 shares per day on average. This suggests that investors have to pay an additional cost for this unpopular (but top performing) product, beyond the annual fees of 95 bps.
Direxion Daily Mid Cap Bull 3x ETF (NYSEARCA:MIDU)
Like CURE, this ETF also delivered about 28% returns so far this year but targets the U.S. mid cap securities. The fund seeks to deliver three times (3x or 300%) the daily performance of the S&P Mid Cap 400 Index, before fees and expenses. The product has a slight tilt towards industrials, closely followed by technology and financials.
The fund has an asset base of $48.8 million and involves a relatively small bid/ask spread, trading in daily volume of about 100,000 shares.
Direxion Daily Financial Bull 3X Shares (NYSEARCA:FAS)
This is one of the largest and popular funds in the leveraged space with AUM of over $1 billion. The fund gained nearly 26% YTD and provides exposure to the financial sector (read: Financial ETFs Set to Rally in Earnings Season). It seeks investment returns that correspond to 3x the daily returns of the Russell 1000 Financial Services Index.
The product is widely diversified across the entire spectrum of market capitalization. It is highly liquid, ensuring no extra cost for the product.